Policy options for maximising downward pressure on electricity prices

Transcription

1 Policy options for maximising downward pressure on electricity prices

2 DISCLAIMER This report has been prepared for the following organisations - Australian Industry Group - Brotherhood St Laurence - CHOICE - Energy Efficiency Council. This report is an independent analysis and thought piece by Oakley Greenwood (OGW), and was commissioned as an input to both public debate and the supporting organisations' consideration of policy options. The paper is intended to support the organisations that commissioned the report to develop policy positions, and these organisations do not necessarily support or oppose any of the policies and data that are set out in the paper. The analysis and information provided in this report is derived in whole or in part from information prepared by a range of parties other than OGW, and OGW explicitly disclaims liability for any errors or omissions in that information, or any other aspect of the validity of that information. We also disclaim liability for the use of any information in this report by any party for any purpose other than the intended purpose. DOCUMENT INFORMATION Project Client Status Report prepared by Policy options for maximising downward pressure on electricity prices The Australian Industry Group, Brotherhood St Laurence, CHOICE and the Energy Efficiency Council Lance Hoch (lhoch@oakleygreenwood.com.au) Date by

3 Table of CONTENTS 1. Executive summary Causes of recent and likely future electricity price rises Options to keep electricity bills affordable Options applicable to the generation sector Options applicable to the network sector Options applicable to the retail sector Options applicable to government Other considerations Background, purpose and approach Background and purpose Approach Conceptual framework Approach used Recent and near-term future electricity prices and price increases Factors that caused the price increases of the past several years Factors expected to affect prices in the coming years Factors that affect electricity prices and their controllability Options for putting downward pressure on costs and improving affordability in the Generation sector Is the sector as efficient as possible? Possible solutions Option G-1: Ability for consumers to sell demand response to the wholesale market Option G-2: Capacity market mechanism Option G-3: Review of reliability standards Options for putting downward pressure on costs and improving affordability in the Networks sector Is it as efficient as it could be Possible solutions Option N-1a: Greater exercise of regulatory power by the AER, including in regard to network capital expenditure and returns (Enhanced and strengthened regulation) Option N1-b: Introduce and support a consumer advocate as a regular participant in network regulatory processes (Enhanced and strengthened regulation) i

4 Option N-2a: Capital efficiency carryover mechanism (Greater efficiency in network capital and operating expenditures) Option N-2b: TOTEX as a more effective incentive for cost-efficiency (Greater efficiency in network capital and operating expenditures) Option N-3a: Increased use of interval metering and time-varying pricing (Better use of demand-side resources, including distributed generation) Option N-3b: Mandated demand-side plans (Better use of demand-side resources, including distributed generation) Option N-3c: Demand reduction targets, incentives and penalties for networks (Better use of demand-side resources, including distributed generation) Option N-3d: Role and return for networks as owners of assets that facilitate demand response and/or distributed generation (Better use of demand-side resources, including distributed generation) Option N-4: Review of reliability standards Option N-5: Privatisation of government-owned network businesses Options for putting downward pressure on costs and improving affordability in the Retail sector Is it as efficient as it could be Possible solutions Option R-1: Pricing options (general population) to support load profile changes, including requirement to offer unbundled pricing options Option R-2: Monitoring of retail costs and margins to ensure effective competition Option R-3: Continued support for NECF Options outside the energy market to reduce consumption and/or peak demand Overview of current government involvement Possible options Option P-1: Review, prioritise and revitalise on-going government initiatives concerning energy efficiency and related issues Option P-2: Explicit consideration of the impacts of new energy and environment related policies on the dynamics of the energy market, and their interactions with the NER and relevant energy market regulation Option P-3: A National Energy Savings Initiative Vulnerable customers ii

5 Table of FIGURES Figure 1: Composition of residential retail electricity prices across the NEM jurisdictions and contribution of various factors to price increase Figure 2: Component costs of residential electricity prices price 2007 to Figure 3: NSW distributors capital expenditure by purpose 2004/05 to 2013/14 (nominal $) Table of TABLES Table 1: Increase in average residential electricity bill (nominal dollars), by state, and the relative contribution of inflation and consumption to the increase Table 2: Projected national average residential price increases through , including the effects of a carbon price Table 3: Expected price rises in residential electricity prices through by electricity supply chain component Table 4: Cumulative change in electricity price FY08 to FY15, for Sydney and Brisbane, excluding carbon prices Table 5: Increases in the component costs of residential electricity prices and Table 6: Factors wholesale electricity costs from 2011 to Table 7: Degree to which the factors affecting electricity prices can be controlled by government policy Table 8: Bill savings from reduced network reliability standards iii

6 1. Executive summary Electricity bills have increased rapidly over the past five years. This has generated significant concern among households and businesses. It has also been commented on in a number of recent reviews of various aspects of the electricity market, but these reviews have generally been undertaken from an electricity industry or market (rather than consumer) perspective, and have often addressed the impact of various aspects of the market on prices separately rather than seeking to address the topic holistically. This independent report was commissioned by the Australian Industry Group, Brotherhood St Laurence, CHOICE and the Energy Efficiency Council to support informed debate by the entire community homeowners, renters, landlords, small businesses and large business, including businesses with significant exposure to carbon prices and regional and global trade issues. The sponsoring organisations do not necessarily support or oppose any of the policies and data that are set out in the paper. The report looks into: the causes of recent and likely future electricity price rises, and options to keep electricity bills affordable Causes of recent and likely future electricity price rises From the late 90s to 2006 or so, growth in peak demand was probably the most significant contributor to increases in electricity prices. This growth in peak demand was largely attributable to the increased take-up and use of air conditioning in the residential sector, and has required investment in both peaking generation and additional capacity in transmission and distribution networks. More recently, electricity prices have continued to increase, despite the fact that the rate of growth in peak demand has slowed. In fact, in several NEM jurisdictions prices have increased more quickly in the past three to five years than they did during the preceding decade. The largest single factor in the price increases that have occurred since 2006 has been increased network charges the charges that are included in consumers bills for the use of the transmission and distribution systems (poles and wire) that deliver electricity from the power plants to end users. While growth in peak demand has played a role in this increase, in several jurisdictions particularly where the increases in electricity price have been the highest the need to replace old distribution infrastructure assets that have reached the end of their useful lives has been a very large part of the cause. In some jurisdictions the reliability standard that distribution networks must maintain has also contributed to the rise in electricity prices. Higher reliability requirements generally increase the need for network infrastructure, which increases costs and therefore prices. 1

7 Looking forward, most studies forecast that price rises will continue with some studies forecasting that 2017 prices for residential customers likely to be double their 2011 levels. Further increases in network charges due largely to the need to replace aged assets but also in part to continued growth in peak demand and existing reliability standards are expected to be a significant cause of these increases. However, some studies expect the wholesale market to contribute even more to the rise in residential electricity prices. The most significant factor putting upward pressure on the cost of generating electricity is expected to be increases in the prices generators have to pay for the fuel they use due to increased exposure of Australia s coal and gas resources to world prices. The introduction of the carbon price has had an impact on prices from its introduction in Its contribution to further price increases is expected to decrease given the current outlook for international carbon prices and the fact that the floor price has been removed Options to keep electricity bills affordable This report looks at options to keep electricity bills affordable, with a focus on options in the structure and operations of the electricity market. The most critical factors for making sure that consumers bills are as low as possible over the long term are to ensure that: Consumers have adequate information, access to services and other resources to assist them in using electricity in the amounts, times and types of equipment that maximises their welfare; The electricity supply industry meets consumers' demands as cost-effectively as possible; The prices that the industry provides to consumers are as cost reflective as practically possible, as this will promote economically efficient decisions by consumers regarding their use of electricity, which in turn will increase the likelihood that the aggregate demand presented to the electricity industry contains as little deadweight loss or economically inefficient consumption as possible; The lower costs to serve that result from the two steps above are reflected in future prices throughout the electricity supply chain and to consumers. From these perspectives, a total of 19 options were identified that could put downward pressure on electricity prices. They are organised and discussed based on the part of the electricity supply value chain whose operation they would affect. This report recognises that low income and vulnerable residential consumers have specific concerns that will need to be considered if some of the options identified here are implemented. This report does not seek to address in detail the implications of the options presented for vulnerable and at risk residential consumers. While these issues can be addressed in part through a robust system of consumer protections (as discussed briefly in the last section of the report), further work will be needed to ensure the specific proposals will not have an adverse impact on vulnerable and at-risk residential consumers Options applicable to the generation sector Prices in the generation sector have been relatively stable and are projected to increase primarily due to the cost of generation fuels (over which policy does not have a great deal of control without introducing other biases) and the introduction of a price on carbon. As a result, the policy options that have been offered for consideration address other means for reducing price pressure in the sector, including: 2

8 Facilitating the provision of demand response by consumers in order to reduce peak demand in the generation market and thereby investment requirements; should this occur there would also be a corresponding (though lower) impact on distribution system peak demands and capital investment requirements Considering the addition of a capacity mechanism to the NEM market design if the above and other approaches for facilitating demand response are not successful Reviewing the NEM s reliability standard to determine whether a lower standard would be acceptable in light of the reduction it would cause in the amount of capacity required, and therefore capital expenditure. A review and possible reform of the gas supply market to ensure it is as liquid and competitive as possible is also warranted, given the growing importance of gas as a fuel for electricity generation and direct use by major customers in a carbon-price world Options applicable to the network sector There is significant potential for measures that build on current regulatory arrangements that would reduce upward pressure on prices in the network sector. These can be thought of in four separate areas: Enhanced and strengthened regulation, including: Greater exercise of existing regulatory powers by the AER The introduction of and provision of support for consumer advocate as a regular participant in network regulatory processes; These options could be pursued at the same time, and in parallel with all other options. Incentives to encourage greater efficiency in network capital and operating expenditures, including: The introduction of a capital efficiency carryover mechanism, which would provide an incentive for network businesses to be more economically efficient in their capital expenditure Making total expenditure the basis on which network businesses would earn a return, thereby assisting in overcoming any bias that exists toward capital expenditure as compared to expenditures on maintenance, demand-side management and/or distribute generation. These two options should be seen as alternatives to one another. Given the nature of the two options and their fit with existing regulatory processes, it would probably be more appropriate to work with the capital efficiency option first. Increased network business proactivity in finding, using and supporting demand side response and demand side resources, including distributed generation. Four separate options are presented in this area: Increased use of interval metering, which could work in concert with more direction from the AER regarding the use of network price structures that provide more efficient pricing signals to consumers. Such pricing would help ensure that the demand of electricity end-users reflected their assessment of the value derived from electricity as compared to the cost of supplying it A requirement for networks to prepare and publish demand-side plans 3

9 The introduction of targets with incentives/penalties for networks to use demand-side resources to defer augmentation (note that there a number of approaches that can be taken to setting the target) The development of a role for networks to serve as owners of and earn returns on assets and services that facilitate demand response and/or distributed generation. This would allow network businesses to use certain network assets (primarily communications and control technologies) to provide demand management services to retailers or aggregators. The first of these four options above can be pursued in parallel with all other options. The second and third options reflect differing levels of obligation being put on networks to become actively involved in enlisting the demand side of the market to provide the most economically efficient approaches for meeting aggregate consumer demand within the network. Either or both could be undertaken, or they could be undertaken sequentially. Implementation of the fourth option should be conditional on a study of its likely impacts on innovation and competition in demand-side services. Review of the nature and level of the reliability standards that are applied to network business. There is a substantial body of research that suggests that the deterministic nature of the reliability standards that apply to the distribution businesses and in some cases the level of those standards are imposing costs that exceed the benefits that consumers obtain from the reliability delivered. There may also be value in considering harmonisation of network reliability standards, which currently vary based on state-level legislation and license requirements. Privatisation of government-owned network businesses. Other, more radical options also exist that could be investigated instead of these approaches, or if these approaches do not sufficiently improve the economic efficiency of the sector Options applicable to the retail sector Although the retail sector s operating costs and margin account for only about 10% to 15% of the average residential bill, there are several options applicable to the sector that would put downward pressure on prices or provide consumers with better information or other benefits. Three options are offered for consideration in this sector: A requirement that retailers provide more cost-reflective pricing options, including an unbundled price as an option to all customers on request. This would provide visibility to network price signals (both the structure and level of the network price) and assist with increasing energy literacy among smaller customers. It would support and encourage more innovative pricing by networks and assure that the price signal was visible to the consumer. Monitoring of retail costs and margins to ensure competition is effective. This would focus on identifying where competition is or is not effective, and is or is not providing benefits to consumers. In any instances in which competition was found to not be effective or to not be providing benefits to consumers, it would also seek to determine the reasons for these shortcomings and means for correcting them. Where it was found to be effective if would facilitate the decision to remove retail price regulation. 4

10 Implementing the National Energy Consumer Framework. The National Energy Customer Framework (NECF) provides a comprehensive set of consumer protection measures for small electricity and gas customers. It also provides far more uniformity in how electricity and gas retailers are directed to interact with their customers than currently exists in the consumer protection approaches that have been developed independently within each of the jurisdictions. This greater level of uniformity is beneficial to the retailers as it reduces their costs of operation, which should therefore reduce upward pressure on prices to consumers Options applicable to government Governments at the federal, state and local levels have an obvious and important role to play as policymakers and as consumers in their own right. While it is absolutely critical that governments maintain and strengthen policies to help households and businesses improve their energy efficiency, this report does not examine or recommend any specific policies to improve energy efficiency. This report sets out two options to ensure that policies that improve energy efficiency also reduce upward pressure on electricity prices: Review and revitalisation of on-going government energy efficiency policies. The Council of Australian Governments is currently undertaking a review of climate change and energy efficiency policies, partly to review their 'complementarity' to a carbon price and partly to review their effectiveness. These are important questions, but it must be remembered that many of the energy efficiency policies being considered under the review were not implemented to serve as complements to the carbon price, but rather to address other issues in the energy market and energy affordability. This review would deliver greater benefits if, in addition to assessing the complementarity of the measures with carbon pricing it also assessed the impact of the various programs on their 'complementarity' with the National Electricity Market, their impact on relevant market failures, and their potential impact on electricity prices and its affordability. Explicit consideration of the impacts of new energy and environment related policies introduced at any level of government on the dynamics of the energy market, and their interactions with the NER and relevant energy market regulation. Where possible, this could be incorporated within any Regulatory Impact Statement or similar analytic measure used by the government in question. It also discusses the application of the intent of these options to the possible development of a national Energy Savings Initiative. It should be noted that there is also a role for government to lead by example. This would include ensuring that its own facilities and operations are energy efficient and provide demand response where possible Other considerations Fully optimising supply and demand requires action beyond just the electricity market - it also requires efficient markets for other goods and services (e.g. appliances, insulation) and policies and programs to address other market failures, such as information asymmetries, transaction costs and access to capital. The report recognises that optimising demand patterns will require these other markets to be efficient, and policies to be in place that address factors and market failures outside the electricity market but it does not examine these issues. 5

11 2. Background, purpose and approach 2.1. Background and purpose Electricity bills have increased rapidly over the past five years. This has generated significant concern among households and businesses. It has also been commented on in a number of recent reviews of various aspects of the electricity market, but these reviews have generally been undertaken from an electricity industry or market (rather than consumer) perspective, and have often addressed the impact of various aspects of the market on prices separately rather than seeking to address the topic holistically. This report was commissioned by the Australian Industry Group, Brotherhood St Laurence, CHOICE and the Energy Efficiency Council to support informed debate by the entire community homeowners, renters, landlords, small businesses and large business, including businesses with significant exposure to carbon prices and regional and global trade issues. This report looks into: the causes of recent and likely future electricity price rises, and options to keep electricity bills affordable. This report was commissioned as an independent thought piece to provide input to both public debate and the supporting organisations' consideration of policy options. The paper is intended to assist the organisations that commissioned the report to develop their respective policy positions, and these organisations do not necessarily support or oppose any of the policies and data that are set out in the paper Approach Conceptual framework This report looks at options to keep electricity bills affordable, with a focus on the structure and operations of the electricity market. The most critical factors for making sure that consumers bills are as low as possible over the long term are to ensure that: Consumers have adequate information, access to services and other resources to assist them in using electricity in the amounts, times and types of equipment that maximise their welfare; The electricity supply industry meets consumers' demands as cost-effectively as possible; The prices that the industry provides to consumers are as cost reflective as practically possible, as this will promote economically efficient decisions by consumers regarding their use of electricity, which in turn will increase the likelihood that the aggregate demand presented to the electricity industry contains as little deadweight loss or economically inefficient consumption as possible; The lower costs to serve that result from the two steps above are reflected in future prices throughout the electricity supply chain and to consumers. Fully optimising supply and demand requires action beyond just the electricity market - it also requires efficient markets for other goods and services (e.g. appliances, insulation) and policies and programs to address other market failures, such as information asymmetries, transaction costs and access to capital. 6

12 The report recognises that optimising demand patterns will require these other markets to be efficient, and policies to be in place that address factors and market failures outside the electricity market but it does not examine these issues. Rather, this report focuses on options in the design, operation and regulation of the electricity market that will improve the overall efficiency of the electricity market and thereby put downward pressure on total consumer bills. As noted above, this report focuses on options to improve the overall efficiency of the electricity market in order to put downward pressure on consumers bills. However, the report does not address the distribution of the benefits and costs of these options in detail, and some low income and vulnerable consumers have specific concerns that will need to be considered if some of the measures identified here are implemented. This report does not seek to address in detail the implications of the different measures for vulnerable and at risk residential consumers. These issues can be addressed in part through a robust system of consumer protections (see Section 8). Further work will need to be undertaken to ensure the options proposed here will not have an adverse impact on vulnerable and at risk residential consumers Approach used The framework was applied in two basic steps: 1. Identify the factors that are contributing to electricity prices being higher than they would be under the most efficient conditions. 2. Identify potential solutions to those problems and assess them with regard to a set of explicit criteria. These are described in further detail below. Step 1: Identify the factors contributing to high electricity prices In order for electricity prices to be as low as possible, the electricity industry itself needs to be as efficient as possible. This will mean that the cost of operating the electricity system is as low as possible, while still allowing applicable supply quality and reliability standards to be met. In order for consumers to make efficient choices about their use of electricity they need: prices that reflect the cost of producing and delivering that electricity information on ways they can modify their use of electricity, including the cost of those modifications and their impact on the consumer. for residential consumers the impacts of most importance are likely to concern comfort and convenience for business consumers they are likely to concern the cost of doing business, and their impact on the business processes and products, as well as their impact on the comfort and convenience of their customers and employees. the ability to act on that information and incentives, which can be impeded by bounded rationality, access to capital, access to skilled experts and third parties and principal-agent issues. It is worth noting, as evidenced in the first two conditions above, that efficiency in the demandand supply-- sides is interactive: an informed and responsive demand side will mean that the electricity being produced is being used in as economically efficient a way as possible, and an efficient electricity supply industry will meet the aggregate demand of those consumers at the least possible cost. 7

13 Step 2: Identify and assess potential solutions The solution options were assessed with regard to the following criteria: Magnitude of impact All other things being equal, policies that address areas where greater gains can be made will be preferred. This is likely to be influenced at least in part by the part of the supply chain to which the potential solution would apply (the relative contribution of the various sectors to final price is discussed in the following section). The assessment of the magnitude of impact of the various options undertaken in this study is in most case qualitative, owing to the time and other resources available to the assignment. Measurability of impact This is important in order to assess whether the policy is working, needs to be amended or should be abandoned. Timing of benefits and costs This will determine an option s near- as well as longer term impacts on prices. Policy options with different time profiles of costs and benefits require different considerations and communications strategies. Likelihood of success This is affected by a number of factors including the number of parties that need to agree to implement the policy, the number of parties that need to take discretionary actions in order for the policy s benefits to be achieved, how easily (or otherwise) the policy is to implement as well as its on-going administrative requirements, its consistency with existing policies and government positions, and its total costs. Specific stakeholder groups Different policy options will affect different stakeholder groups differently. The assessment will identify the specific customer segments and portions of the electricity supply industry that each policy option would affect, both positively and negatively. Consistency with electricity market philosophy and direction Policies that are more consistent with existing policy settings and, in the case of the electricity market, the design of the market and its rules are likely to be easier to implement. 8

14 3. Recent and near-term future electricity prices and price increases This section provides an overview of the degree to which electricity prices have increased over the past decade or so, the degree to which they are expected to increase within the foreseeable future, and the factors that have been and are expected to be responsible for those increases. Due to the availability of data, the review focuses on the residential sector. While the level of price increases in other sectors is not known in as much detail, most of the factors driving costs in the electricity sector will have affected the prices of other consumers as well. The purpose of this section is to identify where policy options are likely to have the most scope to put downward pressure on price or to assist consumers in managing their bills Factors that caused the price increases of the past several years From the late 90s to 2007 or so, growth in peak demand was probably the most significant contributor to increases in electricity prices. This growth in peak demand was largely attributable to the increased take-up and use of air conditioning in the residential sector. That uptake, in turn, was driven primarily by the strong economic growth that characterised the period and the increase in discretionary household income it produced, the availability of imported air conditioning equipment at very low prices, and the fact that electricity for residential users was (and largely still is) priced the same regardless of the time it is used. As noted in The Boomerang Paradox 1 : the number of households in QLD s capital (Brisbane) increased by 35% over the 12 years to FY10, whereas peak electricity demand increased by 104% over the same period; households with air-conditioners had risen from 23% to 72% with 34% of homes running two or more air-conditioners 2. This increase in peak demand required investment in both peaking generation and additional capacity in transmission and distribution networks. More recently, electricity prices have continued to increase, despite the fact that the rate of growth in peak demand has slowed. In fact, in several jurisdictions within the National Electricity Market (NEM) prices have increased more quickly in the past three to five years than they did during the preceding decade. These price increases have been the subject of significant study, though virtually all of the published work in this area addresses only residential electricity prices. An unpublished OGW study conducted in 2011 assessed the causes of the price increases and the relative contribution of each of the various parts of the electricity supply chain and policy measures to the cost of residential electricity in each of the NEM jurisdictions in the middle and latter parts of the last decade. 1 Paul Simshauser, Tim Nelson and Thao Doan, The Boomerang Paradox, 2 Summarised in The Boomerang Paradox from K Orchison, K, Distance cuts down the options, The Australian Climate Change Special Report, 4 March 2010, p.4. 9

15 Table 1 below shows the increase, in nominal dollars, of the average residential bill each of the NEM jurisdictions in the second half of the last decade. It also identifies the share of the increase that was due to inflation, and the degree to which the bills would have been affected by increased usage. As can be seen, in every state but one the majority of the price increase has been due to real increases in the price of electricity, rather than the effects of either inflation or increased consumption -- in fact, in four of the seven jurisdictions average electricity consumption fell over the period. Table 1: Increase in average residential electricity bill 3 (nominal dollars), by state, and the relative contribution of inflation and consumption to the increase %change due to State Period covered Total change in nominal dollars Real electricity price Inflation Change in volume (average annual consumption) QLD FY thru FY $ % 29.2% -2.9% NSW FY thru FY $ % 29.3% -4.4% ACT FY thru FY $ % 42.7% -4.1% VIC 4 FY thru CY 2011 $ % 29.6% -3.9% SA FY thru CY 2010 $ % 52.1% 1.2% TAS CY 2006 thru FY $ % 28.2% 1.9% Source: OGW analysis The relative contribution of each of the various parts of the electricity supply chain and government policy measures to the cost of residential electricity in each of the NEM jurisdictions is shown in Figure 1 below. 3 The information on price movements was in all cases developed from the annual filings of one or more distributors in each state. It was calculated based on the average consumption of all residential customers (total residential class consumption divided by total number of residential customers) and the standard single-rate tariff for the relevant year in each jurisdiction (except Victoria post 2008, where the standing offer tariff was used). 4 Results for CY 2011 were estimated from part-year data. 10

16 Figure 1: Composition of residential retail electricity prices across the NEM jurisdictions and contribution of various factors to price increase 5 Queensland 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of final residential retail price (%) % 2.6% 3.6% 5.6% 8.2% 8.6% 46.6% 42.1% Contribution to increase in retail price (%) to % 46.1% 53.0% 37.2% Wholesale energy Networks Retail Policy New South Wales 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of final residential retail price (%) Contribution to increase in retail price (%) to % 2.5% 1.6% 0.2% 12.1% 17.9% 48.6% 49.8% 52.1% 39.8% 36.4% 30.2% Wholesale energy Networks Retail Policy 5 The cost stack information was developed from regulatory price determinations in each state. Some states do these annually (e.g., QLD) but most have undertaken multi-year price determinations at least at some point, and Victoria ceased doing them when the state de-regulated retail pricing for small customers. As a result, data had to be smoothed across years between determinations and could only be reported for Victoria where reasonably accurate data could be accessed. 11

17 ACT 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of final residential retail price (%) Contribution to increase in retail price (%) to % 3.2% 4.4% 10.9% 10.9% 10.9% 43.7% 44.3% 46.1% 42.7% 41.6% 38.6% Wholesale energy Networks Retail Policy Victoria 6 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of final residential retail price (%) CY 2006 CY % 0.0% 17.3% 16.2% 43.8% 40.8% Contribution to increase in retail price (%) CY 2006 to CY % 38.9% 43.0% 75.1% 7.7% 0.0% Wholesale energy Networks Retail Policy 6 Relevant data for Victoria was only available for the period 2006 to 2008, which is a materially shorter period than that for which data was available for the other jurisdictions. Electricity costs in the 2006 to 2008 period were significantly influenced by drought conditions (which reduced available generation capacity and increased forward contract market prices) and worldwide shortages of turbines and increases in steel prices (which increased forward investment costs). In combination, these factors increased wholesale energy prices. Subsequently, each of those factors subsided and wholesale prices fell in Victoria and across the NEM. As a result, the relative contribution of the wholesale energy market to residential electricity prices will have changed. 12

18 South Australia 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of final residential retail price (%) CY 2010 Contribution to increase in retail price (%) to CY % 0.0% 11.2% 1.0% 5.4% 9.9% 47.4% 46.1% 40.6% 41.1% 41.7% 44.1% Wholesale energy Networks Retail Policy Tasmania 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of final residential retail price (%) CY 2006 CY 2011 Contribution to increase in retail price (%) 2006 to CY % 0.8% 2.1% 4.1% 9.0% 10.6% 46.0% 51.3% 45.4% 37.7% 59.3% 25.9% Wholesale energy Networks Retail Policy Similar results have been reported in other studies. For example, the NSW Electricity Network and Prices Inquiry, which was undertaken by the (then) NSW Department of Industry & Investment in the second half of 2010 found that: 13

19 Electricity prices increased by 41% in nominal terms across Australia in the three years from June 2007 to June 2010, and by 43% in Sydney over the same period. These steep increases follow a sustained period of relatively flat prices in the mid 1990s and only modest increases in the early 2000s as greater competition was introduced to the electricity market and stronger regulatory frameworks were introduced for the remaining monopoly elements in the industry Factors expected to affect prices in the coming years A number of parties have also produced forecasts of electricity prices in the coming years. In its most recent rolling three-year forecast of residential electricity prices, entitled Final Report: Possible Future Retail Electricity Price Movements: 1 July 2011 to 30 June 2014, which was published in November 2011, the Australian Energy Market Commission (AEMC) stated: Taking into account a price on carbon, between the base year (2010/11) and the final year (2013/14) of the projection period, the weighted average national residential electricity price is projected to increase by 37 per cent in nominal terms. This is equivalent to a nominal price increase in the total residential electricity price of 8.34c/kWh, over that period. The average annual growth rate of national residential electricity prices over the three year projection period is expected to be approximately 11 per cent. 8 Table 2 below presents the price increases that the AEMC study forecast over the period, and the contribution being made to those price increases by each part of the electricity supply chain. Table 2: Projected national average residential price increases through , including the effects of a carbon price Component Green energy component (government policies and programs) Nominal percentage increase between 2010/ /14 Nominal price increase between 2010/ /14 (c/kwh) Percentage of total price increase attributable to component 55% % Retail component 30% % Impact of carbon price on % retail costs Distribution component 34% % Transmission component 29% % Wholesale electricity 43% % component Impact of carbon price on % wholesale market Total 37% % Source: AEMC, : Possible Future Retail Electricity Price Movements: 1 July 2011 to 30 June 2014, November 2011, p NSW Department of Industry & Investment, NSW Electricity Network and Prices Inquiry, December 2010, p 7. 8 AEMC, : Possible Future Retail Electricity Price Movements: 1 July 2011 to 30 June 2014, November 2011, p

20 The AEMC report provides a similar analysis on a state-by-state basis. Table 3 below shows the relative contribution of each part of the electricity supply chain to forecast residential electricity prices in each of the NEM jurisdictions over the to timeframe. Table 3: Expected price rises in residential electricity prices through by electricity supply chain component Component QLD NSW ACT VIC 9 SA TAS Government policies and programs 1.1% 12.2% 4.1% 12.7% 11.9% -0.4% Feed-in tariff 0.2% 6.1% 3.9% 0.7% 6.6% 0.0% LRET 3.1% 3.7% 2.7% 3.8% 5.1% 2.5% SRES -1.6% 1.6% -2.3% -2.0% -1.8% -2.9% Energy efficiency and demand management schemes; and smart meter roll-out in Victoria Retail component (including the impact of the carbon price) -0.6% 0.8% -0.2% 10.2% % 0.0% 8.4% 7.1% 7.1% 31.5% 2.7% 11.9% Distribution component 40.2% 36.1% 14.2% 15.3% 39.9% 22.5% Transmission component 6.0% 6.2% 6.1% 0.1% 10.7% 15.4% Wholesale electricity component (including carbon price) Total % increase (2010/11 to 2013/14) 44.3% 38.3% 68.5% 40.4% 34.8% 50.5% 41.5% 41.8% 41.6% 32.7% 36.2% 25.0% Total price increase ( /kwh) Carbon price impact ( /kwh) Source: AEMC, : Possible Future Retail Electricity Price Movements: 1 July 2011 to 30 June 2014, November 2011, p 6. 9 Because retail price regulation was removed in Victoria at the beginning of 2009, the AEMC study had to estimate the wholesale, retail and premium feed-in tariff payment components of the residential price, rather than relying on the results of regulated tariff determinations as was done for the rest of the states. It should also be noted that the figures for Victoria are based on the standing offer, while the majority of the residential customers in Victoria are on market contracts which can entail prices that are lower by 10 to 20% as compared to the standing offer. Finally, it should also be noted that while some of the retail margin in other states is likely to be included in the wholesale price component (due to the allowance made in the regulated tariff), all of the retail margin in Victoria is included in the retail component. 10 The Victorian costs are for the Advanced Metering Infrastructure (smart meter) Roll-out; they do not include the costs attributable to the Victoria Energy Efficiency Target (VEET). 15

21 A few studies have looked farther out in time. The Boomerang Paradox 11 assessed in significant detail the likely cost drivers in each link of the electricity supply chain, including the factors affecting forward costs of generation plant and generation fuels primarily gas. The study considered four scenarios based on higher and lower gas prices and whether or not a carbon price was introduced. The results for the high gas, no carbon price scenario are summarised in Table 4 below. Table 4: Cumulative change in electricity price FY08 to FY15, for Sydney and Brisbane, excluding carbon prices Component FY08 base price: Incremental impact on final residential electricity price ( /kwh) c/kwh Per cent increase on base cost Generation fuel costs 4.62 /kwh 33.8% Generation capacity costs 2.59 /kwh 19.0% Renewables (RET) costs 0.50 /kwh 3.7% Transmission costs 0.51 /kwh 3.7% Distribution costs 3.57 /kwh 26.2% Smart meter costs 0.87 /kwh 6.3% Retail opex and margin 1.32 /kwh 9.7% GST 1.41 /kwh 10.3% Total incremental cost /kwh 112.7% Source: P Simshauser, T Nelson and T Doan, The Boomerang Paradox, April 2010, pp As can be seen, increases in the cost of generation fuel essentially gas and coal constituted the single biggest driver of the cost increases even without consideration of a carbon price. The high gas cost with carbon price scenario resulted in a price that was an additional 4.9% higher than that shown in the table. The low gas cost with carbon price scenario resulted in a price that was 5.9% lower than that shown in the table. And, while increases in distribution charges were found to be the second largest contributor to prices over the timeframe, the combination of generation fuel costs and generation capacity costs resulted in the generation sector having essentially twice the impact on expected residential prices in 2015 as compared to 2008 as the distribution sector. 11 AGL Applied Economics and Research, The Boomerang Paradox, April

22 A study by Port Jackson Partners looked at the cost increases in residential electricity prices over essentially the same period, but broke that into two separate time bands 2007 to 2011 and 2011 to As can be seen in Figure 2 and Table 5, which follows it, this study is projecting that the factors driving price increases from 2011 to 2017 will be quite different from the factors that drove prices in the preceding period of 2007 to Most markedly, it projected that wholesale sector prices, after remaining virtually flat from 2007 to 2011, would double from then to 2017, and grow from accounting for under 7% of the price increases experienced between 2007 and 2011 to become the single most significant factor in residential electricity price increases in the 2011 to 2017 period. By contrast, retail costs and margins and renewable energy costs are projected to account for much less of the upward pressure on residential electricity prices from 2011 to 2017 as compared to the 2007 to 2011 period. Network costs will account for about the same proportion of price increases in the two periods, but while they were the biggest factor from 2007 to 2011, they are now projected to account for just a bit less of the upward pressure on prices in the 2011 to 2017 than costs in the wholesale sector. Figure 2: Component costs of residential electricity prices price 2007 to Retail costs & margin Renewable energy costs Network charges Wholesale cost Table 5: Increases in the component costs of residential electricity prices and Component 2007 to to 2017 contribution to contribution to % increase overall increase % increase overall increase Retail costs and margin 92.3% 26.7% 44.0% 6.9% Renewable costs NA 17.8% 12.5% 0.6% Network charges 29.3% 48.9% 74.2% 45.3% Wholesale electricity 4.2% 6.7% 101.4% 47.2% Total 100.0% 100.0% Source: Edwin O Young, Port Jackson Partners, Australia s future electricity price environment, Presentation to Electricity Price & Market Dynamics Review Conference (IIR Conferences), April

23 The AGL and Port Jackson Partners studies also largely agree on the reasons for the sharp increase in wholesale sector costs, as shown in Table 6. Table 6: Factors wholesale electricity costs from 2011 to 2017 Factors driving wholesale sector costs from 2011 to 2017 AGL Applied Economics and Research A run-up in unit fuel prices as Australian coal and gas resources shift from being priced on their local extraction costs plus a margin to world export market prices An increase in the cost of power plants exacerbated by the increase of capital costs that resulted from the Global Financial Crisis Deteriorating load factors Community environment concerns which have led to a tightening of performance standards that will cause a shift in power generation investments from very low cost coal to lower CO2 emitting gas, and increased use of higher cost renewable capacity via legislated targets, and the possible taxation of carbon emissions Port Jackson Partners Increasing coal prices as coal suppliers gain an export option and as coal contracts come up for renewal Increasing gas prices as the east coast gas market also gains export options Suboptimal investment in peaking generation as regulatory uncertainty is making investment in baseload gas uneconomic (while further coal-fired power stations remain unlikely to be built) Impact of a carbon price on coal and gas Sources: AGL Applied Economics and Research, The Boomerang Paradox, April 2010, and Port Jackson Partners, Australia s future electricity price environment, April The NSW Electricity Network and Prices Inquiry identified the drivers of network costs over the period through , based on the regulatory determinations for those years. As shown in Figure 3 below, growth in demand was the driving force of network costs (and therefore charges to consumers) in NSW in the period from through , and is expected to remain a significant component into the future. However, the replacement of aged assets has been the primary driver of network cost increases in the years since and is expected to continue to be the main driver through

24 Figure 3: NSW distributors capital expenditure by purpose 2004/05 to 2013/14 (nominal $) Source: NSW Electricity Network and Prices Inquiry, p 28. Note: Based on actual expenditure from 2004/05 to 2009/10 and forecast expenditure to 2012/14, and includes EnergyAustralia s transmission system capex. The NSW Industry & Investment study also noted that prices in NSW are expected to continue to increase at a faster rate than other jurisdictions largely because of expected increases in revenues to be recovered by distribution businesses as a result of the 2009 determinations by the AER. The largest increases in allowed revenues in the current determinations of the AER are forecast for EnergyAustralia and Country Energy (over 70 per cent in real terms) and Country Energy (52%). This compares to forecast rises in average revenues of 37% in Queensland, 24% in South Australia and 11% in Victoria. 12 Finally and most recently, the Australian Energy Market Operator (AEMO) has revised its forecast of total electricity consumption and peak demand through In June 2012 AEMO published a revision of its 2011 forecast 14. The revised document forecasts that growth in annual electricity consumption over the period will be 1.7%, well down from its original forecast of 2.3%. Similarly, it described its revised forecast growth rate for peak demand as much lower than in previous years, though in each of the three largest states in the NEM demand growth is still forecast to be higher than growth in total energy consumption, leading to continuing deterioration in system load factors. 12 NSW Industry & Investment, op cit, pp AEMO s Statement of Opportunities is an annual rolling ten-year forecast of electricity consumption and peak demand for several scenarios of weather and economic conditions. It is used as the starting point for generation investment decisions and is also an important input to the calculations that help determine regulated retail prices at the jurisdictional level. 14 AEMO, National Electricity Forecasting Report for the National Electricity Market 2012, June 2012, available at 19